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Legendary money manager Rodriguez says structural changes are key to our fiscal revival but doubts the country's political will to make them

Bob Rodriguez in Lake Tahoe, Nev., where his office is located.

Eight months ago, in a February interview with AdvisorOne, legendary money manager Robert Rodriguez, CEO of First Pacific Advisors, warned that if Congress failed to seriously address the country’s fiscal issues within seven months, financial markets would be hit hard. That prediction has proven to be all too accurate.

Now, in a new AdvisorOne interview, Rodriguez says that current federal and congressional monetary and fiscal policies still do not attack structural issues and have therefore been ineffective.

The country is headed for recession next year, Rodriguez forecasts. His outlook for the markets? Unequivocally cautious. Congress and the Obama administration have created high levels of uncertainty that continue to create volatility and a negative bias in the markets, the money manager says.

Rodriguez forecast the global financial crisis of 2008-2009 as well as the “caterpillar-like” form of the United States’ recovery.

Last January, following a year’s sabbatical, he turned over day-to-day management of the FPA Capital Fund and FPA New Income Fund to his partners, as planned. Rodriguez, a managing partner, remains advisor to both funds.

The Los Angeles-based firm manages assets of $16.2 billion. Compounded rate of return of FPA Capital from its launch in July 1984 through Sept. 30, 2011, is 14.39%. FPA New Income hasn’t had a down year in 33.

Here are excerpts from our telephone interview with Rodriguez, whose office is in Lake Tahoe, Nev.:

What is the biggest threat to the securities market next year?

Continued political incompetence with regard to fiscal issues. From a standpoint of health care as well as fiscal policy, 2012 is the most important year in 80 years.

Are we on the road to another financial crisis?

Unless there is fundamental, structural budgetary reform in the Congress, I don’t trust them. Why should we trust a Congress that has a 13% [Gallup Poll] approval rating with our budgetary future?

What’s your outlook for the economy and stock market in 2012?

Decidedly cautious. I believe Europe is in or near recession and that the odds are increasing north of 50% that the U.S. will be in recession next year. I’m looking for GDP growth at about 1%, probably even lower at times. It’s going to be a very languid year economically, and the stock market will face profitability issues along with governmental issues.

What about bonds?

They’re absolutely terrible. We don’t like the risk in the bond market and haven’t for many years.

What do you propose to turn things around?

A discussion and then implementation of real, substantive congressional budgetary reforms that have a standing in law. In other words, these guys can’t wiggle out of their promises. Federal expenditure and entitlement reforms must involve meaningful cuts in the near future and not at the end of the next presidential term in 2016. And we have to have a radical restructuring of our tax code.

How do you assess Federal Reserve Chairman Ben Bernanke’s handling of the recovery?

Well-intentioned, but his view of the world is and has been incorrect. While he’s been trying to improve the situation, he’s really harming it.

How so?

We have this economic car going down the road: on one side is fiscal policy pressing on the gas pedal. At the same time, the Fed is putting their foot on the brake thinking they’re stimulating the economy with their zero interest rate policy. But they’re hitting savings big-time, which is acting as a detriment to consumption.

And the result?

A totally different outcome of economic recovery than we’ve seen at any point since the Depression. This is a repression! Here we are almost three years into recovery, and we’re having the worst one on record. If the chairman wants to say no cuts or minimal cuts in the next year or two on entitlements, it has to be tied with structural budgetary reform in Congress.

What about President Barack Obama’s plan of reducing the payroll tax?

It does not attack structural issues and thus is an ineffective policy.

Please elaborate on your forecast for Europe.

Greece is gone. There’s no way it can survive under the current structure. Unless they fundamentally restructure the euro–a bastard currency, neither fish nor fowl–the European continent will have continuing and growing problems.

What’s your take on Occupy Wall Street?

I’m very sick and tired of the class warfare card being played. It’s divisive. Obviously, frustration is building. But between 2000 and 2007, the consumer levered up like he had never levered up in U.S. history. More debt was added in those seven years than in the preceding 40 combined. [But] there’s plenty of blame to go around.

For example?

The Federal Reserve was complicit in this [crisis], and the chairman also. Ben Bernanke, at every major turn, has been on the wrong side of the equation. Why should I listen to a person who didn’t believe there would be contagion from subprime? Why should I give credibility to his judgment when his judgment was flawed in so many other areas?

What’s your outlook for jobs next year?

Very little improvement in the unemployment rate. Unemployment could actually rise somewhat.

And housing?

I don’t expect housing to turn around and start moving up briskly in the next one to three years. Unless the stock market runs away, the primary way consumers will rebuild their balance sheets is through savings and debt pay-down. That is not a prescription for a dynamic, growing economy.

What sectors do you like for 2012?

There aren’t any real trends yet. Of the stocks [we’ve] invested in, a couple are in the technology area, one in financial services and one in health care.

What’s the best investment strategy for next year?

You’re going to have to make real selection decisions. Much of what goes on in money management in the professional rank is a form of “closet indexing.” If they’re bullish on an industry and it represents 10% of the index, they’ll own 11% or 12%. If they’re negative, they’ll own 8%. I’m probably being a little too critical about the percentages–but [the point is] in this kind of slow-growth environment, having a broad diversification of stocks and bonds doesn’t work as well.

Any hopeful signs of soon ameliorating the problems you’ve stated?

Some positive things are percolating–emanating from various states. It’s reflecting that the American public is starting to wake up. The problems at the fiscal level can be addressed by our representatives. It takes only one thing: Does the public have the courage to realize that we must go through some painful processes for the benefit of our children and our children’s children? If we don’t go through these, I fear we will be looking at another generation of declining living standards.